A Comparative Study Of Islamic And Conventional Banking Finance Essay

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Banking sector is one of the of import industries in the modern epoch and executing a critical function in today ‘s economic system. ( Chapra, 1985 ) . Conventional banking has become the demand of society as it provides different maps and services which leads to the growing of economic system and increases the efficiency of investing undertakings. The cardinal map of conventional banking is to supply fiscal and non fiscal intermediary services to the group of persons. ( Iqbal et Al, 1998 ) . Banks work on the thought of salvaging and borrowing maps and integrate an involvement factor. Lender gets an involvement on his loaning while borrower pays an involvement on a peculiar rate on his adoptions.
In the past few old ages the major economic crises and fiscal recession changed the whole scenario of conventional banking system which forced authorities in many developed states to take over big conventional banking establishments such as Northern Rock in UK, USA and many Icelandic Banks. Harmonizing to IMF 2008, in USA the net income of Bankss dramatically decreased from $ 35.2 – $ 5.8 billion at the last one-fourth of 2007 due to fiscal loan crises. Since August 2008 related losingss approached at $ 500 billion. These defects in fiscal and banking system decreases the assurance on the banking sector have been highly decreased and universe economic experts are forced to believe about the replacement for the planetary fiscal system.
History of Islamic Banking
History of Bankss can be traced to development of human society and usage of money as a medium of exchange. Modern banking started in Muslim states during nineteenth century when these states came under the control of foreign states as their settlements. Before that they were non so developed economically and politically. Banks were ab initio found in the capital metropoliss and were chiefly involved to ease import and export minutess. Local community ab initio defy banking system due to national or spiritual grounds. As the clip passed it turned hard to avoid commercial Bankss in trade and other activities. However, community still go on to avoid adoption from Bankss and sedimentation into salvaging histories in order to defy engagement in involvement related minutess. As clip passed, engagement in the fiscal and economic market grew and it became impossible to avoid banking system. It was the clip when local engagement in banking sector started and local Bankss started supplying services to local communities and developed within the state.
Islamic banking ab initio started during the times of Prophet Muhammad PBUH when people used to lodge their money with either him or Abu-Bakr Siddique the first calif of Muslims. Modern Islamic banking started in 1971 with the start of Mit ghamr nest eggs undertaking in Egypt which was based on the thought of net income sharing footing. First this undertaking started in form of Nasser ‘s Social Bank in Egypt. Since 1970s Islamic banking is quickly turning. The growing rate is 10 % -15 % since late 1990s and expected to maintain on turning for many old ages. ( Financial services reappraisal – grand 2008 )
In a figure of states, Islamic fiscal services offered by the fiscal establishments are important and quickly turning portion in the fiscal system. Since its debut, Islamic banking about 30 old ages ago, significant addition is found in the figure of Islamic Financial Institution from its debut in 1972 to around three hundred in over more than seventy five states. In some states about bulk of the fiscal establishments operate under Islamic banking system and are Sharia’h compliant. Get downing from Middle East and Asia now Islamic banking has noticeable topographic point in Europe and USA every bit good. Entire assets held by Islamic Bankss worldwide can be estimated at $ 500 Billion with an expected growing of 15 % per annum.
1.2 Introduction to Islamic Finance and Banking
Muslims believes in one Allah Who created adult male and appointed him frailty trustee on the Earth who fulfils the certain aims through high quality of Allah in the Black Marias of the Muslims in any affairs of life including banking system. Allah gave counsel to work forces and adult females through holly books of Quran by Prophet Muhammad PBUH ( Usmani, 2002 ) .
Islamic Banking System differs from conventional banking as it opposes the bear downing involvement in fiscal minutess but the basic maps of banking are the same as without them any economic system can non run. It implies that Islamic Bankss are non permitted to give fixed return on investing to clients and on the same clip are non permitted to bear down fixed rate on loans to borrowers. It does non intend that Muslims do non borrow or put financess with Bankss. The maps of fiscal systems in both banking systems are about the same. Similarly, the practical jobs related to these maps are besides common to Islamic and Conventional fiscal systems. ( Usmani, 2002 ) .
Islamic Banking System offers assorted fiscal merchandises to its clients parallel to the conventional banking merchandises. Profit-Loss-Sharing ( PLS ) provides solution to extinguish involvement. Other merchandises include Mudarabah that is sharing of net income and Musharaka that is joint venture. This architecture of sharing makes banking system more risk-taking because non all the hazard is absorbed by the bank and sharing of hazard with investor enable the bank to run the undertakings on long term footing or to finance long term undertakings that are largely high return undertakings. The loaner and borrower both should portion the hazard as neither party controls the result of the undertaking and hereafter is unsure.
Islamic banking is non merely for Muslims as Islamic Bankss offer same services as conventional Bankss do i.e. credence of sedimentations, imparting money, Islamic signifier of mortgage, Ijarah i.e. the signifier of leasing, Takaful i.e. the signifier of insurance etc. Because of the suitableness and rightness of these fiscal merchandises these are widely accepted in Non-Muslim universe every bit good. Muslim Bankss can be seen in UK, Europe, USA and Australia. Furthermore, some conventional Bankss have started Islamic banking within their subdivisions designated for conventional banking.
The true conventional banking system is based on capitalist economic system rule, in other words a net income motivation and private ownership. This means that the more you have more you can acquire or little you have small you can acquire. The funding of conventional banking are backed by money and pecuniary documents that oppose the construct of Islamic banking which backed by 100 percent assets of equal measure ( Usmani, 2002 ) .
Why Islamic Banking
Islamic Banking is based on the principal of sublimating the beginning of income. Islamic banking is inevitable due to basic spiritual grounds. Harmonizing to Islamic instructions, the psyche nourished by non-pure beginning of income is indictable to hellfire. Another expression is, cipher can go forth his topographic point on the twenty-four hours of opinion unless and until he answers his beginning of income and ways of disbursement. ( Muhammad Farhan ul Haq usmani 2009 )
Islamic economic system is based on the thought of justness and equality rule, where all human are treated every bit. Islamic finance facilitates good being of full society alternatively of involvements of clump of persons. The chief construct or thoughts of Islamic banking are consistent with rules of Islamic jurisprudence ( Sharia ) , which is wholly involvement ( Riba ) loose. Interest ( Riba ) means adding or increase, related to loan and progresss are out ( Haram ) in Islamic fiscal system ( Siddiqi, 1985 ) .
1.4 Brief construct of Islamic Banking
Islamic Banking System provides a assortment of fiscal services acceptable to Muslim community from spiritual position. Islamic Banking establishments eliminate the reception and payment of involvement. It differentiates Muslim Bankss in chief from conventional Bankss. Furthermore, there is besides prohibition of Maysir ( guess or chancing ) and Gharar ( unreasonable uncertainness ) . Investings should be made in Halal ( permitted ) activities merely and the society is benefitted from the aggregation of Zakat that is monitored by a spiritual board.
The inquiry that if reception and payment of involvement is purely prohibited so what does Bankss gain is answered by PLS ( Sharing of Profit and Loss ) as a theoretical account for sharing of resources. Normally used funding minutess include ( Mudarabah ) Trustee finance, ( Musharaka ) Equity engagement and ‘Mark-up methods. Some of the concern partnerships normally used in the Middle East before Islam were in kernel Mudarabah and Musharaka but they were co-existed along with involvement based loans as a agency of funding concern minutess.
( P 03:10 M.Kabir ) … ?
Scope in UK and Europe
Harmonizing to official research conducted by The Times, there is significant addition in the Muslim population in Britain that is gown from half a million to two and half 1000000s in short span of four old ages.
Analysts say that such a rapid growing is 10 times faster than what others did during this period. Experts attribute the addition to in-migration, a higher birth rate and Conversions to Islam during the period of 2004-2008.
Harmonizing to UK national statistics Muslim population in UK has reached around two and half million which histories for 3.8 % of the entire population. Same tendency has found in other portion of the Europe as good where Muslim population ranges from 1.5 % to 8.8 % of the entire population. Every state should hold the autonomy to pass their lives harmonizing to their religion. These increasing Numberss emphasise the thought that Muslims should be given an chance to carry through their banking demands in conformity with Islamic Banking System.
% age
Fifty eight and half million
Eight hundred 50s thousand
1.5 %
Forty three million
One million
2.3 %
United Kingdom
Fifty nine million
One and half million
2.5 %
Nine million
One-fourth million
2.8 %
Eighty two and half million
Three million
3.6 %
Ten and half million
Half million
4.8 %
Seven and half million
One-fourth million
3.3 %
Five and half million
One-fourth million
4.5 %
Sixteen and half million
One million
6.1 %
Sixty two and half million
Five and half million
8.8 %
1.9 Islamic Banking in UK
Harmonizing to the Guardian ( 2008 ) , entire Muslim population in the Britain is now 2.0 million. It started in the mid twentieth century when Muslims from Middle East started to migrate to the U.K. after World War II. They started to do their ain community, Mosques, spiritual topographic points, Islamic administrations like schools and non for net income administrations. Presently there are more than four Muslim MP ‘s in the House of Commons which includes Minister and about 200 Councils all over the state. In the U.K Muslims have freedom to pray in Mosques, to eat Halal nutrient and celebrate spiritual occasions. ( The Guardian, 2008 ) .
In the early 1990 ‘s Islamic banking came into the fiscal market of U.K for the first clip. The basic maps of banking do non differ that ‘s why Islamic banking did non acquire clip to distribute into the market. Holy Quran ” and the Sunnah ” of Prophet Muhammad PBUH clearly define the regulations and rules of Islamic banking which are the basic guidelines for Muslims. The first Islamic bank in the U.K was established in 1982 with the name of The Al Baraka International Bank Followed by the Ahli Bank of Kuwait in 1997. Their rules were based on Murabaha and Ijara manner of finance.
With the early origin of Islamic banking and it ‘s increasing popularity the conventional banking realized the chance and planned assorted fiscal services which are acceptable for Muslims. Due to the addition in Muslim community it was necessary to acquire the Muslims attached with the market. In 1998, HSBC took the enterprise of Islamic banking with the start of Amanah bank history. HSBC is besides the first non Muslim bank who started mortgage services with pure Islamic jurisprudence. ( HSBC Amanah, 2009 ) .
Since the early reaching of Islamic banking in 1970 ‘s the entire figure of Islamic fiscal establishments are over 300 today which are in 75 different states including Muslim and non Muslim states. This singular success leads to the point that Islamic banking does give us the best alternate banking solution.
Harmonizing to UK & A ; Trade Investment, 2007, U.K is the first member of EU which authorized Islamic banking in the state. Its parts of Islamic banking are more than 20 old ages now which has made U.K the Centre of pick for the western community in the proviso of Islamic banking and finance. Harmonizing IFSL ( 2008 ) , today in the UK there are 22 Bankss which are offering Islamic finance relating services and merchandises. This includes 5 Bankss with pure Sharia jurisprudence and more than 17 conventional Bankss with Islamic Windowss runing under fiscal service authorization ordinance ( IFSL, 2008 ) .
Harmonizing to the Banker, 2008, the entire worth of Islamic finance related assets in the UK presently exceeds ?12 billion, of which includes Islamic manners of funding such as Murabaha, Ijara and Sukuk and Takaful financess ( The Banker, 2008 ) .
About all the major Bankss in the UK have started Islamic Banking within their subdivisions. Muslim Bankss runing in UK include
ABC International Bank PLC
Ahli United Bank
Bank Negara Indonesia
Barclays Capital
Halal Financial Services Inc.
HSBC Amanah Finance
Islamic Bank Of Britain
Muslim Mortgages ”
1.10 Purposes and aims of the research paper
This thesis survey compares the typical characteristics of Islamic Banking System / Islamic Finance and Conventional Banking System in modern-day system. Explains both systems in the visible radiation of basic features of each system and how a Banking System can be categorised as Islamic Banking System. Explains fiscal merchandises in each system and in peculiar fiscal merchandises in Conventional Banking System, their legality and deduction in Islamic Banking System. Furthermore, this paper besides discuss if there is benefit of making Islamic banking so it should besides be offered to non-Muslims and to the economic system in general.
However, chief intent of this research paper is to analyze the merchandises in the conventional banking system, their worthiness in the eyes of Islamic bookmans and why each of them are Haram ” illegal in Islamic banking system and more significantly what changes needs to be done in their current construction to do it suited for Muslims.
Another thought is to analyze the Islamic banking merchandises, its practical facets, jobs in execution and schemes required for successful Islamic fiscal environment.

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